United Capital Research

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1 United Capital Flas Note United Capital Researc I Nigeria I Oil & Gas I Equities Nigeria (Downstream) Oil and Gas 05 May 2015 Drivers and Drags. Were is te balance of risk? Te drumbeats of full deregulation are getting louder United Capital PMS demand is forecast to it 41mn liter/day in 2015 Crude Oil Price Slump; negligible impact on downstream players Foggy Climate of Uncertainty will stiffen Q earnings Diversification and retail expansion will support profitability in 2015 Cost efficient players will be better off United Capital Securities Trading Unitedsecurities@Unitedcapitalgroup.com Asset Management assetmanagement@unitedcapitalgroup.com Trusteesip trustees@unitedcapitalgroup.com Curr. Price Target Price Return Ratings P/E (x) P/BV (x) ROE (%) Div. Yield (%) Mkt. Cap (N'Mn) Total Assets (N'Mn) SHF (N'Mn) Net Margin(%) Revenue (N'Mn) CONOIL % Sell ,128 94,483 16, ,716 FO % Sell , , , ,547 MOBIL % Hold ,100 49,227 13, ,866 OANDO % Buy na , , , ,548 TOTAL % Buy ,796 95,512 13, ,811 Source: Company Filings, Bloomberg, United Capital Researc Te drumbeats of full deregulation are getting louder Altoug te fall in crude oil prices and te resultant effect on landing cost of Premium Motor Spirit (petrol) as seen subsidy bill per liter drop significantly, te strain on government revenue as brougt te complete deregulation of te downstream sector to te front burner. Judging from te body-language of te incoming administration regarding te oil and gas sector and te approval of te recommendation for te complete removal of subsidy by te FAAC committee in April 2014, we tink subsidy reforms are now imminent in te near term. Wat s more, te 2015 budget makes zero allocation for subsidy payments. but it may take a longer time tan te market anticipates We tink te full deregulation of te sector via total subsidy removal olds te maximum benefits to players in te downstream. However, we note tat tis is practically a daunting task given current political dynamics. Moreover, complete subsidy removal remains unpopular among major oil producing countries globally. Te current scenario owever makes market players worse off given mounting pressure from FX weakness. More importantly, it is unsustainable for te government in ligt of current fiscal pressures. We terefore envisage a pased deregulation of te sector, were subsidy removal is staggered alongside domestic refining capacity build-up. Ultimately, a full deregulation of te sector will lead to market-determined petroleum prices. Tis will support top-line growt for players even as market determined pricing of petroleum products will attract significant level of private investment in te sector wic will lead to increased competition, iger level of productivity and lower prices. In spite of te direct impacts o from macro eadwinds, te Oil and Gas sector as outperformed te market in te last one year NSE ASI Oil & Gas Apr-14 Aug-14 Dec-14 Apr-1 NSE, United Capital researc Analyst: Kayode Omosebi kayode.omosebi@unitedcapitalplcgroup.com Team lead: Kayode Tinuoye Kayode.tinuoye@unitedcapitalplcgroup.com

2 United Capital Researc Furtermore, a deregulated downstream sector will attract interest in local refineries and pipelines. We expect te privatization of te four (4) stateowned refineries 2 in Port-Harcourt (PHRC) and 1 eac in Kaduna (KPRC) and Warri (WRPLC) to commence tis year wile greenfield refineries are expected to begin production in te near term. We also foresee some downstream players embarking on investment in refineries as te sector opens up. Petrol Demand to it 41mn liter/day in 2015, wit plenty room for upside Petrol demand is expected to be about 41mn liter/day in 2015 from 39mn liter/day in Demand for petrol may grow to 51mn liter/day in 2020 and could it 60mn Current liter/day Price by Te projected 24.3 increase in petrol consumption 2015 in Year 2015 Hig stems from increasing 25.2 industrial, transportation, tecnology and infrastructure needs as well as residential needs mostly for 2015 Year Low 17.0 cars and generators. We do not expect a quick fix in te power reform by te YTD Return -3.6% incoming administration, terefore PMS demand from generators will remain ig in te near Average term. Volume We believe (mn units) Nigeria is going troug 21.7 a process of energy transition wic Average will drive Value demand traded ( for N'mn) energy going forward. On average, fuel contributes c.90% of revenue for te quoted downstream players wile PMS contributes c.78% of revenue. Te projected increase in petrol demand will support revenue growt; a drop in cost of sales (post-deregulation) wile efficient local refineries will improve revenue margin of downstream players. PMS Consumption per liter in Nigeria (Historical & Forecast) Billions Source: CITAC, United Capital Researc Crude Oil Price Slump; negligible impact on downstream players In a deregulated market, drop in oil price will bode well for downstream players as crude oil prices correlate positively wit te all-in cost of refined products. For subsidy-paying countries, tis also means lesser occurrence of under-recoveries on account of selling fuels below cost. Altoug oil marketers mostly get fully compensated for te under-recoveries, payments from te government come wit long delays wic usually forces players into eavy borrowing and stretced balance seets. Tis said, it is important to note tat since te drop in crude oil price is supply driven, rater tan demand, tere is noting to worry about for downstream players. However, despite te decline in input costs for deregulated products suc as AGO and lubricants, te existing regulated environment continues to restrict expansion in te operating margins of players in te downstream.

3 United Capital Researc PPPRA PRODUCT PRICING TEMPLATE PMS Based on Average Platts Prices for 27t April, 2015 Average Excange Rate of te NGN =N= to US$ for 27t April, 2015 PMS Cost Element $/MT Naira/Litre 1 C + F Trader s Margin Ligtering Expenses (SVH) NPA Financing (SVH) Jetty Depot Tru Put Carge Storage Carge Landing Cost Distribution Margins: 9 Retailers Transporters Dealers Bridging Fund Marine Transport Average (MTA) Admin Carge Subtotal Margins Higway Maintenance 17 Gov ernment Tax 18 I mport Tax 19 Fuel Tax 20 Subtotal Taxes 21 Total Cost ** Ex-Depot (for collection) ** Under/Ov er Recov ery Retail Price Expected Open Market Price (OMP) (Naira/litre) is Landing cost +Margins * C+F price is Offsore Nigeria Conversion Rate (MT to Litres): 1341 Excange Rate (N to $): 197 * Official Ex Depot is exclusive of Bridging Fund, Marine Transport Average (MTA) & Admin. Carge * *Ex Depot includes Bridging Fund, Marine Transport Average (MTA) & Admin. Carge *** Effectiv e Date of New Approv ed Pricing Template is 19t January, 2015 Data is as at 27/04/15

4 United Capital Researc Foggy Climate of Uncertainty will stiffen Q earnings It is no news tat te 2015 budget of N4.5trn wic as been passed by bot te upper and lower camber as sown total exclusion of fuel subsidy payment. Toug we expect te budget to be reviewed by te incoming administration, we tink te lack of clarity and foggy climate of uncertainty will affect operations of players in te sort term and stiffen Q numbers. Te recent devaluation of te Naira as affected operation of downstream players in terms of forex differentials of under recovery of subsidy and a longer period in dollar bidding to import petrol. Tis as led to a reduction in importation of PMS over te past four monts. Furtermore, downstream players ave been faced wit eavy financial burden due to outstanding subsidy payments; te resultant effect of tis is an increase in impairment carge on loans to downstream players by te bank. Te lack of clarity and foggy climate of uncertainty certainly means tat te banks will be muc more cautious in extending credit to te downstream sector wile players will ave to tread carefully in future imports. However, we believe tis issue is temporary as we expect te incoming administration to provide clarity on te future of te industry wic will guide operators. but diversification and retail expansion will support profitability in 2015 Players in te industry ave begun to pus sales of non-regulated petroleum products troug enanced distribution and retail network. Petrol sales promotes sales of oter petroleum products, terefore evenly distributed service station will elp drive sales of oter products. Furtermore, growing market sare will play a major role. Petrol margin is slim at 10% of pump price, terefore pusing volumes and growing market sare is key to operating profitably. Players wit low market sare will end up as fringe players wit eavy investment outlays yielding low returns. OANDO and TOTAL dominate te market Market Sare by turnover based on recent fillings FO 10% Eterna 7% Mobil 6% MRS 6% Oando 40% Conoil 12% Total 19% Source: Company Fillings, United Capital Researc

5 United Capital Researc Strong brand name, retail outlet distribution, good tecnical support and strategic assets will elp support retail expansion. We expect te big downstream players to expand teir operations into refining post deregulation. Forte Oil and OANDO ave diversified teir business to nontraditional petroleum marketing activities, wit FO s acquisition of Geregu power plant and OANDO s acquisition of ConocoPillips s assets; we expect tis to drive growt for bot companies. We expect to see greater efficiency in cost management Te recent drop in petrol pump price means an increase in subsidy payments, wic ave often been delayed; ence players ave ad to borrow more to offset cost due to lengtened subsidy reimbursement on te back of government s weak fiscal position. Given our outlook of a long route to full deregulation, we believe cost management will be a major driver of profitability in te medium term. We expect opex-to-sales ratio to drop by 3bps to 7.2% for 2015 but te retail drive of most players will exert pressure on OPEX. We tink players like Mobil will continue to be pressured by its iger operating leverage relative to te industry wit opex-to-sales ratio of 10% versus peer average of 7.5% despite its past stellar performances in cost efficiency. Overall, we tink downstream players will need to manage cost efficiently especially for deregulated products. We expect to see a decline in industry cost-to-sales to 88.3% and an average of 88.5% for te next 5 years toug reduction in petrol price and oter cost factors will pressure top line and stiffen margin in te sort term.

6 United Capital Researc Investment Rating Criteria United Capital Researc adopts a 3-tier recommendation system for assets under our coverage: Buy, Hold and Sell. Tese generic ratings are defined below; Buy: Based on our valuation and subjective view (if any), te total return upside on te stock s current price is greater tan our estimated cost of equity. Hold: Based on our valuation and subjective view (if any), te total return upside on te stock s current price is less tan te cost of equity, owever, te expected total return on te stock is greater tan or equal to te Standing Deposit Facility rate of te Central Bank of Nigeria (wic is currently MPR 200bps; i.e 10%). We consider tis as te minimum return tat may deserve our olding of a risk asset, like equity. Sell: Based on our valuation and subjective view (if any), te total return upside on te stock s current price is less tan te Standing Deposit Facility rate of te Central Bank of Nigeria (wic is currently MPR 200bps; i.e. 10%). We consider tis as te minimum return tat may deserve our olding of a risk asset, like equity, especially as we consider te average 4.5% total transaction cost for an average retail investor. NR*: Please note tat in addition to our tree rating eads, we indicate stocks tat we do not rate wit NR; meaning Not-Rated. We may not rate a stock due to investment banking relationsips, oter sources of conflict of interests and oter reasons wic may from time to time prevent us from issuing a rating on te sares (or oter instruments) of a company. Please note tat we sometimes give concessional rating on stocks, wic may be informed by tecnical factors and market sentiments. Current Stock Rating Dispersion and Relationsip Conflict of Interest: It is te policy of United Capital Plc (UCAP) and all its subsidiaries/affiliates tat researc analysts may not be involved in activities tat suggest tat tey are representing te interests of UCAP in a way likely to appear to be inconsistent wit providing independent investment researc. In addition, researc analysts reporting lines are structured so as to avoid any conflict of interests. Precisely, researc analysts are not subject to te supervision or control of anyone in UCAP s Investment Banking or Sales and Trading departments. However, suc sales and trading departments may trade, as principal, on te basis of te researc analyst s publised researc. Terefore, te proprietary interests of tose Sales and Trading departments may conflict wit your interests as clients. Overall, te Group protects clients from probable conflicts of interest tat may arise in te course of its business relationsips.

7 United Capital Researc Analyst Certification Te researc analysts wo prepared tis report certify as follows: 1. Tat all of te views expressed in tis report articulate te researc analyst(s) independent views/opinions regarding te companies, securities, industries or markets discussed in tis report. 2. Tat te researc analyst(s) compensation or remuneration is in no way connected (eiter directly or indirectly) to te specific recommendations, estimates or opinions expressed in tis report. Oter Disclosures United Capital Plc or any of its affiliates may ave financial or beneficial interest in securities or related investments discussed in tis report, potentially giving rise to a conflict of interest wic could affect te objectivity of tis report. Material interests wic UCAP may ave in companies or securities discussed in tis report are disclosed: UCAP may own sares of te company/subject covered in tis researc report. UCAP does or may seek to do business wit te company/subject of tis researc report UCAP may be or may seek to be a market maker for te company wic is te subject of tis researc report UCAP or any of its officers may be or may seek to be a director in te company(ies) covered in tis researc report UCAP may be likely recipient of financial or oter material benefits from te company/subject of tis researc report. Company Dangote Cement Plc Dangote Flour Plc Dangote Sugar Plc Diamond Bank Plc FirstBank Holdings Nigeria Plc Guaranty Trust Bank Plc Guinness Nigeria Plc PZ Nigeria Plc Transnational Corporation of Nigeria Plc Disclosure g, Disclosure keys a. Te analyst olds personal positions (directly or indirectly) in one or more of te stocks covered in tis report b. Te analyst(s) responsible for tis report (wose name(s) appear(s) on te front page of tis report is a Board member, Officer or Director of te Company or as influence on te company s operating decision directly or troug proxy arrangements c. UCAP is a market maker in te publicly traded equities of te Company d. UCAP as been lead arranger or co-lead arranger over te past 12 monts of any offer of securities of te Company e. UCAP beneficially own 1% or more of te equity securities of te Company f. UCAP olds a major interest in te debt of te Company g. UCAP as received compensation for investment banking activities from te Company witin te last 12 monts. UCAP intends to seek, or anticipates compensation for investment banking services from te Company in te next 6 monts i. Te content of tis researc report as been communicated wit te Company, following wic tis researc report as been materially amended before its distribution j. Te Company is a client of UCAP k. Te Company owns more tan 5% of te issued sare capital of UCAP

8 United Capital Researc Disclaimer United Capital Plc. Researc (UCR) notes are prepared wit due care and diligence based on publicly available information as well as analysts knowledge and opinion on te markets and companies covered; albeit UCAP neiter guarantees its accuracy nor completeness as te sole investment guidance for te readersip. Terefore, neiter UCAP nor any of its associate or subsidiary companies and employees tereof can be eld responsible for any loss suffered from te reliance on tis report as it is not an offer to buy or sell securities erein discussed. Please note tis report is a proprietary work of UCAP and sould not be reproduced (in any form) witout te prior written consent of UCAP Management. UCAP is registered wit te Securities and Excange Commission and its subsidiary, United Capital Securities Limited is a dealing member of te Nigerian Stock Excange. For enquiries, contact United Capital Plc, 12t Floor, UBA House, 57 Marina, Lagos. United Capital Plc